Real negative interest rates are easy to imagine when inflation is higher than the interest rate. But nominal negative interest rates have long been thought of as either inconceivable or unsustainable. Yet, in recent years, several European countries and Japan have made negative nominal interest rates a reality. The most extreme case seems to be Switzerland, which is featured in the top graph: The spot rate, the 3-month LIBOR, and even the 10-year government bond rate are all negative now and have been for several years. How is this possible?
This isn’t a case of an economy that needs major stimulus through low interest rates. Rather, it’s an export-focused economy whose currency has a strong tendency to appreciate; in fact, the Swiss franc is considered a refuge currency in times of crisis. The crisis at hand involves the euro’s various troubles in recent years, including the debt problems of some of its member countries. Switzerland has avoided these troubles and has even managed to achieve successive government surpluses. So it’s easy to understand why there’s so much demand for Swiss francs and bonds. But so much demand typically causes a local currency to appreciate, which would make exporting more difficult. The Swiss National Bank, therefore, has adopted a policy of negative interest rates to make the franc less attractive. Interestingly, the effect permeates the Eurodollar market as well, as shown in the bottom graph.
How these graphs were created: NOTE: Data series used in these graphs have been removed from the FRED database, so the instructions for creating the graphs are no longer valid. The graphs were also changed to static images.
On June 11, 2014, the European Central Bank broke new ground by lowering one of its key policy rates below zero. That is, the rate in question (the rate on the deposit facility available overnight to European banks) is now negative. While a policy rate can in principle be set at any level, it is more difficult to think about a market interest rate that would be negative. Indeed, one would always earn a higher return by simply holding on to one’s money rather than depositing it for a negative return. Yet, the graph shows two rates—one in Switzerland and one in Denmark—that are in negative territory.
What’s special about Switzerland and (more recently) Denmark? The Swiss franc has a reputation as a very stable currency and hence acts as a refuge currency when trouble is brewing elsewhere. Given that Switzerland is a small economy, when the Swiss franc is high in demand worldwide, investors are willing to accept negative rates if they think their own local currencies may depreciate. This happened when the fixed exchange rate regime of Bretton Woods was in jeopardy, later when European currencies were volatile, and recently when the European Monetary Union went through some pains and few non-euro currency options were available. One of those currencies was the Danish krone, which then also found itself in the role of a refuge currency.
How this graph was created: Search for “immediate rates,” select the relevant countries, and click on the “Add to graph” button.